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Edited Transcript of INFO earnings conference call or presentation 24-Sep-19 12:00pm GMT

Q3 2019 IHS Markit Ltd Earnings Call

London Oct 1, 2019 (Thomson StreetEvents) -- Edited Transcript of IHS Markit Ltd earnings conference call or presentation Tuesday, September 24, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Edouard Tavernier

IHS Markit Ltd. - SVP of Transportation segment

* Eric J. Boyer

IHS Markit Ltd. - VP, IR

* Lance Uggla

IHS Markit Ltd. - Chairman & CEO

* Todd S. Hyatt

IHS Markit Ltd. - Executive VP & CFO

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Conference Call Participants

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* Alexander Kramm

UBS Investment Bank, Research Division - Executive Director and Equity Research Analyst of Exchanges, Ebrokers

* Andrew Charles Steinerman

JP Morgan Chase & Co, Research Division - MD

* Andrew William Jeffrey

SunTrust Robinson Humphrey, Inc., Research Division - Director

* Ashish Sabadra

Deutsche Bank AG, Research Division - Research Analyst

* Drew L. Kootman

Cantor Fitzgerald & Co., Research Division - Research Analyst

* Gary Elizabeth Bisbee

BofA Merrill Lynch, Research Division - Analyst

* Jeffrey Marc Silber

BMO Capital Markets Equity Research - MD & Senior Equity Analyst

* Joseph Anthony Vafi

Canaccord Genuity Corp., Research Division - Analyst

* Keen Fai Tong

Goldman Sachs Group Inc., Research Division - Research Analyst

* Kevin Damien McVeigh

Crédit Suisse AG, Research Division - MD

* Manav Shiv Patnaik

Barclays Bank PLC, Research Division - Director & Lead Research Analyst

* Shlomo H. Rosenbaum

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

* Toni Michele Kaplan

Morgan Stanley, Research Division - Senior Analyst

* Trevor Romeo

William Blair & Company L.L.C., Research Division - Associate

* William Arthur Warmington

Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the IHS Markit Third Quarter 2019 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Eric Boyer, Head of Investor Relations. Thank you. Please go ahead, sir.

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Eric J. Boyer, IHS Markit Ltd. - VP, IR [2]

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Good morning, and thank you for joining us for the IHS Markit Q3 2019 Earnings Conference Call. Earlier this morning, we issued our Q3 earnings press release and posted supplemental materials to the IHS Markit Investor Relations website.

Our discussion on the quarter include non-GAAP measures or adjusted numbers, which exclude stock-based compensation, amortization of acquired intangibles and other items. IHS Markit believes non-GAAP results are useful to enhance understanding of our ongoing operating performance but they are supplement to and should not to be considered in isolation from or as a substitute for GAAP financial information. Please refer to our earnings release on our website for definitions of the non-GAAP measures and reconciliations to the mostly directly comparable GAAP measures.

As a reminder, this conference call is being recorded and webcast and is copyrighted property of IHS Markit. Any rebroadcast of this information, whole or in part, without the prior written consent of IHS Markit is prohibited. This conference call, especially the discussion of our outlook, may contain statements about expected future events that are forward-looking and are subject to risks and uncertainties. Factors that could cause actual results to differ materially from expectations can be found in IHS Markit's filings with the SEC and on the IHS Markit website. After prepared remarks, Lance Uggla, Chairman and CEO; and Todd Hyatt, EVP and Chief Financial Officer, will be available to take your questions.

With that, it's my pleasure to turn the call over to Lance Uggla. Lance?

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [3]

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Okay. Thank you, Eric, and thank you for joining us for the IHS Markit Q3 Earnings Call.

Today, I'll talk to the highlights of the quarter and then provide an update to our capital allocation framework, which looks to return more capital to shareholders through continued share repurchases and our intent to initiate a quarterly dividend pending Board approval.

Included in our capital allocation section, we'll also discuss the divestiture of our Aerospace & Defense business, which we have agreed to sell subject to regulatory approval.

So now turning to the quarter. I was extremely pleased with Q3 as our teams delivered another strong quarter of diversified revenue growth, margin expansion and strong cash flow. We also delevered to within our target range and completed our promised repurchase of 500 million of shares in early Q4. Finally, we closed the asset exchange with Informa and have already achieved early revenue synergies.

Now some key financial highlights of the quarter: revenue of $1.112 billion, that's up 6% on an organic basis and 11% overall; continued solid performance across our 3 scaled verticals: Transportation, Financial Services and Resources; adjusted EBITDA of $453 million and margin of 40.7%, which is up 170 basis points year-over-year; and finally, adjusted EPS of $0.67, up 16% over the prior year.

Now let me provide some segment highlights. Transportation performed within our range of high single digits with organic revenue growth of 7% in the quarter. It's notable to point out that the recurring fixed remained very strong at 10%, offset by lower-margin nonrecurring growth and some impacted continued weakness within digital advertising as expected. We also had slower, low margin recall activity.

The Automotive highlights in the quarter to shout out for performance include: our CARFAX used car listings driven by investments in search optimization, driving market share gains, which we expect to continue; our CARFAX for Life launch met early targets with over 1,100 unique dealers signed up to date; our powertrain and appliance offerings rising on increased regulatory demands; and finally, automotiveMastermind benefiting from the first half launch of 2 additional automotive brands and ongoing enhancements in our product offering, which now leverages many of our proprietary automotive data sets.

Let's move on to Financial Services, where we reported 6% organic growth with several notable areas to call out: Our pricing and index businesses, each with double-digit growth on the back of recent investments. Derivative processing returned to growth in the quarter. Our corporate actions and EDM software sales continued their strong growth trajectories. And finally, Ipreo had a strong overall quarter with significant growth in private markets, corporate solutions and municipal issuance. After a tough start to the year due to market conditions, we're now performing more in line with our acquisition target level on a run-rate basis, which I'm particularly pleased about.

In Resources, we delivered another solid quarter with 6% organic growth anchored by stable recurring revenue growth and strong nonrecurring revenue growth. Strong performance in the quarter included our downstream pricing business, Opus, as well as our chemical business. Our upstream business continued its steady performance. We continue to make progress with recent investments in analytics and partnerships to extend our leading data and insight capabilities into new revenue streams.

We made headway on our integration of the agribusiness acquisition with our chemical and downstream businesses. This integration will build upon our existing data, pricing insights, forecasting and news services within our Resources segment. Agriculture is the largest chemical end market in the world, and this transaction expands our capabilities into fertilizers and chemical crop protection, while expanding our capabilities in biofuels.

Finally, I'd like to call out a great example of our market leadership and capabilities in the wake of the recent Saudi Arabia oil field attack. On the Monday following the weekend of the attack, our Resources team hosted a webinar, which pooled together our experts across upstream, downstream and Economic & Country Risk to brief our customers on the potential implications. Over 1,700 clients joined live with over 600 of those coming from the financial services. Really great work by the team being able to pull together such comprehensive brief in, in a short bit of time to help our customers, both corporates and financial market participants, better understand.

Moving on to CMS. Organic revenue growth was 5%, benefiting from the biannual Boiler Pressure Vessel Code. We continue to expect CMS organic growth to be in the low single digits for the year, in line with our forecast. Product design, the largest business within CMS, continued to perform well with organic revenue growth of 4%.

Finally, I want to give an update to our capital allocation framework as we completed our delevering post the Ipreo acquisition. Our targeted leverage range is going to remain 2 to 3x on a gross basis and will tend to operate at the higher end of the range. We'll target an annual capital return to shareholders of a minimum 50% and as much as 75% of our annual capital capacity through a combination of share buybacks and a cash dividend. At our October Board meeting, I tend to recommend -- I intend to recommend that the Board approve a new share buyback reauthorization and a quarterly dividend program beginning in Q1 '20 with an initial 1% dividend yield target.

We believe 2020 is the right timing for the initiation of a dividend for the following reasons: First, it'll be over 3 years since the successful merger of IHS and Markit, and we have confidence in our ability to continue to operate within our longer-term annual financial framework, including 5% to 7% (sic) [6%] organic revenue growth; 100 basis points of adjusted EBITDA margin expansion; and double-digit earnings growth. We believe this framework balances the right level of investment and margin expansion to continue to maintain our organic growth range. Second, our business model generates ample free cash flow for both capital returns and M&A. Third, we have reduced our legacy Markit option overhang to now approximately 10 million outstanding options at the end of Q3. And fourth, we believe initiating a dividend is a great way to diversify our capital return discipline and to broaden the potential groups of shareholders that may be interested in IHS Markit.

Now in terms of M&A, we will be focused on deploying capital within our scaled focused areas, including Financial Services, Resources and Automotive. Sizing of potential deals will fit within our updated capital allocation framework. We'll also continue to evaluate opportunities to further rationalize our portfolio, which could provide incremental capital flexibility.

With that said, we then put into a letter of intent to sell our Aerospace & Defense business for $470 million to Montagu. We believe this is the right long-term move for us, our shareholders and our Aerospace & Defense colleagues.

The combination of these points around capital allocation gives us a clear framework to operate within to meet our financial objectives. It provides our shareholders of at least approximately $800 million of capital return annually and our division ample acquisition capital to support our longer-term financial targets.

And with this, I'll turn the call back over to Todd.

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Todd S. Hyatt, IHS Markit Ltd. - Executive VP & CFO [4]

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Thank you, Lance. Our Q3 results were in line with our expectations and included: revenue of $1.112 billion, an increase of 11% and organic growth of 6%.; net income of $39 million and GAAP EPS of $0.10; adjusted EBITDA of $453 million, an increase of 16% more with margin of 40.7%.; and adjusted EPS of $0.67, an increase of $0.09 or 16%. Relative to revenue, our Q3 organic revenue growth of 6% included recurring organic of 6% and nonrecurring organic of 4%.

Looking at segment performance. Transportation revenue growth was 6% percent, including organic revenue growth of 7% and negative 1% FX. Organic growth that was comprised of 10% recurring and flat nonrecurring. We expect recurring to continue to perform at the upper end of our high single-digit organic growth range. Nonrecurring was impacted by lower recall and lower digital marketing. We expect nonrecurring to continue to perform at a lower level than recurring due to revenue reductions primarily in our lower-margin recall business.

Resources revenue growth was 9%, including 6% organic and 3% acquisitive. The organic revenue increase was comprised of 5% recurring and 15% nonrecurring. Nonrecurring benefited in part from continued strength in our software business. Our Q3 organic ACV increased $10 million, and our trailing 12-month organic ACV increased $28 million to $757 million, which was up 4% versus prior year.

CMS revenue increased 1%, including 5% organic, negative 4% from divestiture and negative 1% FX. Recurring organic was flat and nonrecurring organic increased to $8 million or 41%. All-in and nonrecurring organic benefited from the BPVC release, which contributed $8 million organic growth in the quarter. Within the segment, our Product Design, core specs and standards business continued to perform well with recurring organic growth of 4%.

Financial Services revenue growth was 21% including 6% organic, 16% acquisitive and negative 1% FX. Recurring organic was 7% and nonrecurring organic declined $4 million or negative 15%. Recurring revenue partially benefited from revenue catchup on past-due renewals. Nonrecurring decline was primarily due to lower enterprise software revenue.

Our information business organic growth was 6% due primarily to strong growth in our core pricing and index businesses. Processing organic was flat. Derivative processing was up but was offset by decline in our loans processing business. Solutions organic growth was 4%, led primarily by our EDM and corporate actions businesses. Ipreo revenue increased to $89 million and included 1-month organic revenue contribution in the quarter.

Turning now to profits and margins. Adjusted EBITDA was $453 million, up $62 million or 16% versus prior year. Our adjusted EBITDA margin was 40.7%, up 170 basis points on a reported basis and up 100 basis points normalized for Ipreo and FX. Our year-to-date adjusted EBITDA margin was 40.3%, which was up 130 basis points on a reported basis and up 100 basis points normalized for Ipreo and FX. We continue to track to our 100 basis points full year normalized margin expansion but expect an increased level of onetime investment in Q4.

Regarding segment profitability. Transportation's adjusted EBITDA was $134 million with margin of 42.6%, down 50 basis points. Resources' adjusted EBITDA was $101 million with margin of 43.8%, up 360 basis points. CMS adjusted EBITDA was $31 million with margin of 22.4%, up 30 basis points. Financial Services adjusted EBITDA was $199 million with margin of 46.4%, up 240 basis points normalized for Ipreo and on a reported basis.

Adjusted EPS was $0.67 per diluted share, a $0.09 or 16% improvement. Our adjusted EPS excluded a $200 million onetime GAAP tax expense related to tax reform and also excluded a onetime gain of $112 million related to the sale of our TMT business.

Our GAAP tax rate was 86% and our adjusted tax rate was 18%. Our GAAP tax included $200 million expense related to treasury regulations issued in June 2019 that changed retroactive to fiscal year 2018 certain pre-U. S. tax reform deferral rules. We expect a favorable offsetting $50 million GAAP tax adjustment in Q4 resulting in a net 2019 GAAP tax expense increase of $150 million.

We have excluded this onetime GAAP tax expense from our adjusted tax expense. This onetime GAAP tax expense essentially offsets the 2018 onetime GAAP tax benefit of $141 million related to tax reform, which was also excluded from our adjusted tax expense. This change will not impact our going-forward effective tax rate and in future years, we continue to expect a low-teens GAAP tax rate and an adjusted tax rate of 18% to 20%. Cash tax owed from this rule change is approximately $90 million, which will be paid in Q4 of 2019. Despite the negative cash impact in 9019, tax reform has been an overall net positive for the company.

Our Q3 free cash flow was $343 million, and our trailing 12-month free cash flow was $1.129 billion and represented a conversion rate of 65%. On a full year basis, our cash conversion will be negatively impacted by approximately 5 points due to the onetime Q4 tax payment of $90 million.

Turning to the balance sheet. Our quarter-end debt balance was $5.05 billion and represented a gross leverage ratio of approximately 2.9x on a bank covenant basis. In the quarter, we completed a $350 million add-on to our 10-year April 2029 bonds at an effective interest rate of 3.25%. We closed the quarter with $124 million of cash, and our undrawn revolver balance was approximately $1.6 billion.

In Q3, we completed a $200 million ASR, and we executed a further $300 million ASR in Q4. Our Q3 weighted average diluted share count was 410.9 million shares.

In terms of portfolio activities, we closed the acquisition of Informa's agriculture business on June 30, and we also closed the sale of a majority our TMT market intelligence business to Informa on August 1. As a result of the exchange, our annual CMS revenue will decline by approximately $60 million while our annual Resources revenue will increase by $40 million. The exchange is slightly dilutive to adjusted EBITDA and neutral to adjusted EPS.

Finally, as Lance said, we signed a definitive agreement to sell our A&D business to Montagu for $470 million. The purchase price represents an adjusted EBITDA multiple of 14 to 15x on a business with approximately 45% adjusted EBITDA margin. We expect net after-tax cash proceeds from the transaction of approximately $440 million. The transaction will result in $0.03 of forward adjusted EPS dilution. We will use proceeds from the disposition to reduce leverage, which will provide us with further capital structure flexibility as we execute against our new capital allocation framework.

In regard to our new capital allocation framework, as Lance said, we will target capital return to shareholders of 50% to 75% of our annual capital capacity through a combination of share buybacks and dividend. We define capital capacity as our annual free cash flow plus the additional capacity generated by adjusted EBITDA growth.

We are updating our prior guidance to provide for: Revenue of $4.40 billion to $4.42 billion, which includes full year organic revenue growth of 5% to 6%. Absolute revenue is lower than prior guidance range due primarily to higher drag from FX as we expect full year negative FX impact of $35 million and also due to the anticipated lower revenue from the TMT ag asset swap. Adjusted EBITDA tracking above midpoint of prior guidance range of $1.75 billion to $1.78 billion. We expect adjusted EBITDA margin expansion of 170 basis points on a reported basis and also normalized for FX and Ipreo. Adjusted EPS at the high end of our prior guidance range of $2.52 to $2.57. We have updated guidance items between adjusted EBITDA and adjusted EPS in our supplemental materials. Finally, we expect cash conversion of approximately 60% due to the onetime tax payment in Q4.

We will provide detailed 2020 guidance in November. However, at this time, we expect to deliver to our double-digit adjusted EPS growth target, taking into account expected dilution from the A&D divestiture. In addition to double-digit adjusted EPS growth, we will see additional TSR benefit from our dividend initiation in 2020.

And with that, I will turn the call back over to Lance.

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [5]

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Thanks, Todd. So in conclusion, another strong quarter: an updated capital allocation framework to increase transparency and capital return to shareholders, an updated guidance that puts us in a position for a very strong year. We appreciate your continued support and are pleased that so many of you have trusted us in executing post-merger and beyond.

Operator, we're ready to open the lines for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Manav Patnaik with Barclays.

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Manav Shiv Patnaik, Barclays Bank PLC, Research Division - Director & Lead Research Analyst [2]

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Congratulations on the new capital allocation framework. Maybe just to follow-up on the Aerospace & Defense sale. I was wondering if you could just walk through the rationale on why you picked that. You obviously have really good margins. Can you maybe talk about the growth, fit? And just want to clarify like, is Jane's basically all of Aerospace & Defense? Or did more than that go in the deal?

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [3]

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No, it's just Aerospace & Defense. I guess, when we look at Transportation in IHS Markit, there's 3 major components: so there's Automotive, maritime and Aerospace & Defense. And when you look at the big synergies, revenue synergies, areas to invest, the areas to grow across the group, Automotive and maritime fit as before, but not just Transportation but across Energy and into financial markets, whereas Aerospace & Defense stood alone. It had a slight overlap with our Economics & Country Risk business. But in terms of forward investment and commitment to invest further, it fell outside of our capital allocation and, therefore, made sense for divestiture.

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Operator [4]

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Our next question comes from Gary Bisbee with Bank of America Merrill Lynch.

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Gary Elizabeth Bisbee, BofA Merrill Lynch, Research Division - Analyst [5]

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Can you just give a little more color on the nonrecurring revenue weakness at both the Financial Services and Transportation business? The -- just what really drove that? And should that -- or the reasons those factors would continue going forward?

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [6]

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Okay. Maybe I'll start and then I'll pass to Todd. So I guess, I don't see financial weakness in either division. So I know when you look and dissect numbers, if you take Transportation, for example, the big driver there being Automotive, and when you look at Automotive, you've got 10% recurring outstanding performance across the group, well diversified, all sectors across the group. When you look at the nonrecurring piece, you really have to -- you have about $600 million of nonrecurring to consider across the whole group. About 20% of that is recall, and a big piece of recall is lower margin, where we're doing recall indirect to the OEMs and it's a defined -- as we look to expand margins and look at our mix of business around recall, we want to do more direct activity with the OEMs, which is higher margin and suits our overall business best and a little bit less of the indirect business. We also had -- we've called out for several quarters now, a bit of a slowdown in the digital advertising side. And so those coupled together in the quarter for a slight decline in recurring -- or sorry, in nonrecurring. But in terms of the margin EBITDA and our forward growth profile, nothing's changed on Transportation, very pleased with the growth and diversification of it.

Financial markets, I will have to say, had a real strong quarter. But there's always lots of things within a quarter. We -- previous quarter, we had a large software sale that shows up. That bodes well for a piece of revenue. This quarter, we got Ipreo firing on all cylinders. That definitely helped and came in to play a little bit. We -- really, it's mixed EDM and corporate actions, superstrong. But even some of the software assets that haven't grown quarter-over-quarter, all are performing within expectations.

So I think the message here is you should have no change in your forward outlook for any of our 3 scaled verticals. They're all operating exactly as we say each quarter. Don't see anything to change. We generally move the guidance up a little bit around at least to the mid to upper ends of EBITDA, upper ends of EPS. And really, the revenue, we had to give up some revenue on the TPT -- TMT agri swap, and we've got $35 million of FX. So when I look at it all, I think this is the best quarter since post-merger in terms of strong diversified teams executing really well.

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Operator [7]

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Our next question comes from Bill Warmington with Wells Fargo.

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William Arthur Warmington, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Analyst [8]

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So I had a question about the particularly strong performance at Ipreo at 22%. Was there something there in the timing or with deferred revenue that made that particularly strong? I just wanted to try to get an apples-to-apples number there. And the reason is I'm just trying to get to a kind of a steady-state, ongoing organic revenue growth rate for that.

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [9]

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Yes, go ahead, Todd.

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Todd S. Hyatt, IHS Markit Ltd. - Executive VP & CFO [10]

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Yes. Ipreo contributed $5 million of organic in the quarter. It had a very good greater. The quarter was in the teens growth. We had 1 month of organic, and it had a particularly strong last month of the equator. I think when we've talked about Ipreo, we talked about a double-digit growth. So wouldn't expect all-in 22%, although I think PCM's performing very high toward that high teens into the 20s level. But Ipreo, certainly, we expect to be a double-digit grower going forward, Bill.

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [11]

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Thanks, Todd.

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Operator [12]

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Our next question comes from Andrew Steinerman with JPMorgan.

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Andrew Charles Steinerman, JP Morgan Chase & Co, Research Division - MD [13]

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I know you've have already mentioned that the Resources ACV is trending up 4%. Could you just talk a little bit more about the Energy backdrop right now. Is it conducive for acceleration? And I note that Resources subs growth at 5% is above the ACV growth at 4%.

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [14]

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Right. Well, I think the -- I think in all our divisions -- and I know in Resources, volatile energy prices makes many think that there should be more volatility within IHS Markit. The same with SARS and Automotive. I think for 3 years, I've said, I don't personally spend a lot of time focusing on a particular indicator to drive overall performance.

So what are we doing? We're doing consulting. It's a piece of the business that actually in the quarter outperformed, if anything. And on that side, it's teams advising people that are making decisions in volatile markets and volatile prices. They're interested in, should they lend to a project? Shouldn't they? Should they buy an asset? Shouldn't they? Are there -- do we have information in and around the energy market that can help people better model supply and demand. And? I'd say that the new data science and analytics around -- coupled with consulting, give us some really good market fundamentals around us, not that I think we're going to be north -- double digits north of 10%. But I do think that we have a solid business that supports mid-single digits.

And the other thing I would say is as you go -- in volatile markets, the downstream pricing and news of all these refined products having daily prices, weekly forecasts, monthly reporting and insights, it really is a place where IHS Markit has had and continues to support high -- mid to upper single-digit growth, and that's around Opus. It's the new agribusiness. So its downstream chemicals into agriculture. It's our chemicals business itself and all the inputs into various supply chains. We really do have a strong position. And then you have renewables on top of that, which is a growth segment all around cleantech that we're playing into. So I really think it's a great mix.

And the only piece where I look at, over the last 5 years, where there's out or underperformance is taking our core few hundred million, so 30% of the division, pure data assets that supports the overall division. And I would say that is where you get a bit of this volatility. But the division operating and being managed effectively can more than support flat to up 5 or even down 5 on that $300 million. And that's how I look at it, Andrew. So I think that volatility's our friend in terms of advice, but it can take away some of the desired explore and expand and new international projects. But we have more than enough skin in the game in this big marketplace to support mid-single digits growth.

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Operator [15]

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Our next question comes from Andrew Jeffrey with SunTrust.

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Andrew William Jeffrey, SunTrust Robinson Humphrey, Inc., Research Division - Director [16]

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A little bit of a hypothetical, I guess, for you, Lance, but pertinent, I think timely, regardless. I know complexity in auto sort of generally aids your growth and demand for your services. I wonder if you -- if you think about what's happening in the U.S., this sort of bow around emissions and the deal that California cut with 4 major auto manufacturers, sort of a side deal to federal -- potentially changing federal emissions laws. Can you talk about how that might affect your auto business if you have sort of 2 major U.S. markets?

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [17]

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Right. Well, we are – actually, our advisory around regulatory and reporting in Automotive actually had quite a good quarter, not purely because of that, just because of our position there. I also have our Head of Automotive here with me today in the room, Edouard Tavernier, so I'll let him jump in on the question that you asked specifically.

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Edouard Tavernier, IHS Markit Ltd. - SVP of Transportation segment [18]

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Great. Thank you, Lance. And generally, the full answer to your question is regulatory uncertainty creates risk for our customers, and that creates demand for our services, demand for our data and demand for a lot of advisory we can provide around scenario planning and simulation. So generally speaking, tough environment for our customers, but we can help them through this uncertainty.

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [19]

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Great. Thanks, Edouard.

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Operator [20]

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Our next question comes from Kevin McVeigh with Crédit Suisse.

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Kevin Damien McVeigh, Crédit Suisse AG, Research Division - MD [21]

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Congratulations on the asset sales. I guess, 2 things: Is the Aerospace & Defense, is the sale in the guidance? Or is that something that will be adjusted going forward? And then just, it sounds like, Lance, you're taking a more focused view across the scaled verticals. Does that imply anything for the remaining CMS business? Or how should we think about that within the context of scaling up, obviously, which are 3 real nice assets?

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [22]

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Okay. I'll let Todd do the guidance after I just talk about the divestiture. So yes, very focused. I have to say, very focused on our automotive, financial markets and energy-related scaled verticals. Those are the very large verticals of the firm, and they are the ones that we're strategically investing in, in terms of -- for organic growth, putting capital to work. We have a lot of data science, analytics and investment into each of those areas. And we made bolt-on acquisitions that we think are effective in supporting our longer-term growth targets and supporting our customers.

So within CMS, we have divested the very -- the noncore portion of TMT, and we've now divested AD&S from Transportation. And so one thing I did call out today is that we'll continue to look within this capital allocation framework at potential other divestitures. And I guess, what I want to say to both shareholders and the employees inside the firm, that this has to be a very thoughtful process. We have to think about the overall long-term potential for our firm, but we're not going to make short-term decisions that are careless or reckless. Rather, we're gonna invest in the assets, the people of the assets that we may think are noncore, and we'll look for opportunities to make different business decisions going forward.

And we're not afraid of analyzing our own portfolio. It's the backdrop of many acquisitions over many years, and where we want to know that we win every day is in the scaled verticals that we're building for long term. And outside of that, we've got to take a very careful, respectful approach to our assets, our shareholders, our customers and our people. But there's no lack of strategic thought from myself or my management team.

Todd, do you want to add on the guidance side?

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Todd S. Hyatt, IHS Markit Ltd. - Executive VP & CFO [23]

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Yes. The disposition of A&D is not included in the guidance. It hasn't closed. It's subject to regulatory filings and approvals. I did provide, I think, sufficient

(technical difficulty)

In terms of the revenue EBITDA and forward adjusted EPS. And certainly as we guide in 2020, we will be very clear on the impacts that are embedded or have been adjusted out of the 2020 guide for A&D.

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Operator [24]

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Our next question comes from Alex Kramm with UBS.

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Alexander Kramm, UBS Investment Bank, Research Division - Executive Director and Equity Research Analyst of Exchanges, Ebrokers [25]

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Yes. Hopefully, I'm not repeating anything, but I was hoping that you could just flesh out the capital return a little bit more. So bear with me for a second. So if I hear you correctly and I do my math right, the dividend is now basically 25% of your free cash flow and you've got another 25% to 50% for share buyback and then another 25% or so for whatever, M&A, et cetera. So I'm just wondering, the buyback, I guess -- is the low end of the buyback, the 25%, is that guaranteed or for the right deal, you would say like, all right, buybacks we can certainly forgo for a year or so if we need to? Or does everything have to come out of new leverage and then I guess, the percentage of the buyback?

And then also Todd, very quickly. You said you're using the proceeds for deleveraging. I guess, the question is why? It seems like you're kind of like in that range now. So why do you choose deleveraging for the incremental? And could you go to 100% capital return in the U.S. as well is the last one. Sorry, for the lot of question.

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [26]

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Yes, go ahead, Todd, if you want to start and I can always add.

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Todd S. Hyatt, IHS Markit Ltd. - Executive VP & CFO [27]

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Just to size like the capital capacity of the company and the capital return elements, so when I think about it, we have circa annual cash flow of call it, $1.250 billion a year. And then we have additional capacity that we generate from adjusted EBITDA growth. So you can take the EBITDA growth and the leverage ratio, the 3x, and called out $400 million. So essentially, the baseline capital is $1.6 billion. And we've said 50% of that will go to capital return at a minimum, up to 75%. So in terms of the allocation between dividend and buyback at a 1% dividend yield, we would think of that as a $275 million annual dividend, and that leaves a minimum of $5.25, $5.50 of share buyback. So that would be the baseline minimum capital return that we will execute on an annual basis.

As far as additional cash, like from the A&D/Jane's disposition, we would expect that, that capital would be available from a strategic perspective to potentially acquire other assets. And so that's why we're, in the near term, going to bring leverage down a bit to have a little bit of dry powder. But ultimately, as Lance said in his opening comment, we're going to run the company in the high 2s. And so if we don't have opportunity to deploy that capital, we would then look at increasing the level of the buyback above the $500 million to $525 million level.

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [28]

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Yes, I think that was it. So thanks, Todd. That's -- I think it's really important for us. We've listened to our shareholders over the past 3 years and defining a capital framework that we're completely happy to provide to you and be transparent with and then live within the guideline is what we've done today. And so you've got the minimum levels and then from that, we'll adjust on the annual basis based on the best remaining opportunity for us as a firm.

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Operator [29]

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Our next question comes from Jeff Silber with BMO Capital Markets.

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Jeffrey Marc Silber, BMO Capital Markets Equity Research - MD & Senior Equity Analyst [30]

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You had talked earlier about the impact of volatility, I believe, in your Energy business. I'm wondering with everything that's been going on in the overall markets, what have you seen on the Financial Services side? Is that impacting maybe some buying decisions going forward?

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [31]

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So are you referring to private equity advice that we may provide to private equity that may be investing in energy-related assets? Was that your question?

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Jeffrey Marc Silber, BMO Capital Markets Equity Research - MD & Senior Equity Analyst [32]

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I was interested more in the Financial Services vertical.

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [33]

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Okay, so the Financial Services with respect to our advising and selling them energy-related products or just overall in Financial Services?

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Jeffrey Marc Silber, BMO Capital Markets Equity Research - MD & Senior Equity Analyst [34]

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The latter, if possible. But if you want to give a little bit on the former as well, that would be great.

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [35]

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Okay. So I do find Financial Services a growth -- ever since the merger, it's one of those revenue synergies that's been a growth driver for us, and it's really coming from twofold: One, we have the Financial Services customers that IHS stand-alone didn't have a deep relationship. So we definitely have that wind on our back in terms of opening doors and participating. The second thing I'd say is private equity had been very active in terms of investments in and around the energy market. Third, I'd say that when you look at growth in renewables and solar, wind, et cetera and you look at the investment profile and where the investments are coming in those projects, a lot of them are being driven out of the financial markets. And private equity's playing a big role in terms of investing.

So we have some really nice growth parameters coming from our relationship with financial markets; and then two, the investments, whether it was in the Permian but now in terms of the whole renewable space, where we've got expertise to help on the advisory and on the subscription data sides in those nonfossil fuel-related areas. So that's been good for us.

Volatility in energy means our financial market clients want more information and support. That's also good for us. Overall, what I would say in financial markets is the last few quarters -- and Ipreo is a great bellwether for it, is that you see -- first off, what you see is there's been fairly buoyant equity market issuance. And if you look at Ipreo and you go, where does Ipreo have volume-related or transaction-related nonrecurring upside, it's around equity market issuance. That's been very good. Lower interest rates also encouraging municipals to get out there and lock in, and we've seen a large issuance of municipal bonds, and we've been hitting some record numbers there.

And then finally, I called out derivatives processing. And whenever there's volatility in FX or rates, you get volatility in and around the processing and activities of derivatives, not that there's more total dollar value but there's more transactions. A lot of times, they're smaller, and we've seen some increased activity there.

So net-net, I think that the financial markets and the general geopolitics and global dynamics around the markets we're in have been good for an information company that had a lot of quantity, quality and different types of data to offer to our customers. So I think it's bode well for us, and it's been quite a diversified quarter that I'm particularly pleased about.

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Operator [36]

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Our next question comes from Shlomo Rosenbaum with Stifel.

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Shlomo H. Rosenbaum, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [37]

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I just want to ask a little bit about the divestitures and the portfolio positioning that you guys have been doing a good job of. Could you discuss how fast the A&D business had been growing revenue-wise? And then on a similar vein, can you talk a little bit about the components of what's left at CMS? And how fast they've been growing?

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [38]

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Okay. So Aerospace & Defense has been a low to mid-single-digit grower with good margin and a superstrong brand position with superstrong engaged employees in that business. And what's great about -- it really is -- Jane's is one of these 100-year old brands that has people that are just passionate about defense, military spend, new weaponry. And we really do have kind of industry experts in and around that asset. But it needs to grow, and it has potential to grow at upper single digits, even double digits with increased investment. And the home for that at Montagu is a better home than with us. Because if I look at our investments priorities across the whole group, I'm looking at where we have our scaled verticals but then also, how do those scaled verticals with data science and analytics play across each other into our financial market participants. And automotive and energy are 2 huge asset classes that financial markets invest in: private equity, bank lending, insurance, asset and index inclusion or exclusion, and we have just so much to offer. Whereas Aerospace & Defense, it just plays a much more specialized, smaller role, and we don't get the same leverage across the group. Therefore, we classified it as noncore, and we decided several months back to look at the divestiture.

We did similar when we took the piece of TMT and did the Informa swap, and that worked out very, very well. So here, we had 2 thoughtful divestitures with a lot of care around our teams and our group. And we think the homes are better for them where they are.

When you get into other assets, and I get asked this question regularly. And because CMS is less scaled than the others, of course, it's always on the question board in terms of shareholders. And all I can say is if I made a divestiture in another piece of the company, it could be a year, it could be 2 years, it could be 5 years, it could be never. What I will promise you is that, well, we're managing our assets. They're going to be properly managed, properly cared for. We're going to focus on the margin. We're going to focus on the people. We're going to pay our people well, look after them well, serve our customers that have served in those markets for many, many years. And if there's an opportunity for a divestiture that makes sense, where -- I hope you can see we're not afraid of divesting an asset if all the right pieces come together. And all I can say is on Aerospace & Defense and the TMT swap, those pieces did come together. And therefore, we were able to execute.

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Operator [39]

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Our next question comes from Ashish Sabadra with Deutsche Bank.

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Ashish Sabadra, Deutsche Bank AG, Research Division - Research Analyst [40]

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We saw some pretty robust margin expansion within financial and Resources. You also talked about some onetime investment in the fourth quarter. Can you just provide some more color on those investments? And then maybe just going forward, the margin profile has been trending much better. Can you just talk about the potential for better margins going forward?

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [41]

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Right. Well, I'll start, and Todd, if I leave some out. I guess I just want to really, once again, just put the line in the sand. 100 basis points since we merged, we've been operating off of 100 basis points of margin expansion. And that's both an internal discipline and an external promise. So that's what we've made. The discipline is for our teams to grow at 5% to 7%, and half of that 100 basis points will come from revenue growth and the other half has to come from them organizing their strategy accordingly. And we feel that we can move to mid-40s margins over the next 4 or 5 years.

Many occasions, our teams outperform the 100 basis points margin. But what my motivation to my internal teams are is deliver the discipline for the 100 and improve your investment capacity above that. And that's the mantra. That's how we run the firm. That's how all our teams operate. It works very well, and I think it's a fair distribution of our efforts to shareholders and our teams in terms of reinvestment, and that's how we run the firm.

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Operator [42]

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Our next question comes from George Tong with Goldman Sachs.

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Keen Fai Tong, Goldman Sachs Group Inc., Research Division - Research Analyst [43]

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Your guidance for free cash flow conversion from EBITDA was updated from mid-60s to 60%. Can you discuss why your free cash flow expectations are more muted now?

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [44]

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Todd, you want to answer that?

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Todd S. Hyatt, IHS Markit Ltd. - Executive VP & CFO [45]

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Yes. I talked about this on the call. That's the onetime tax payment of $90 million in Q4 will reduce conversion by 5 points. We don't see an impact on the forward conversion.

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [46]

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Thanks, George.

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Operator [47]

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Our next question comes from Joseph Foresi with Cantor Fitzgerald.

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Drew L. Kootman, Cantor Fitzgerald & Co., Research Division - Research Analyst [48]

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This is Drew Kootman on for Joe. Just curious if you could you talk about the acquisition pipeline and if you're seeing plenty of opportunities still out there.

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [49]

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Well, there's lots -- yes, there's always lots of opportunities, not necessarily priced where we would be able to make them work in terms of our own return on invested capital. So it's interesting. As we -- I would say the year after our merger, we had lots of work to focus on integration. As we went into year 2, we saw lots of places where we had gaps in our strategy as we looked forward in our scaled verticals, and we made a few acquisitions.

I would say right now, we're in the strongest point we've ever been to support consistently our organic growth targets. And I don't ever wake up and feel there's something we have to do. Where, at the time of the merger, we all felt as a team that we had some gaps around alternatives, around being on the dealer floor, around expanding and diversifying downstream our Energy and natural resources. And I think we've done an excellent job of filling those gaps, broadening the diversification and consistently delivering the organic growth we say we're going to do. And I think if I look forward, I just feel really -- comfort in that mid-single-digit revenue growth. And you know how I think on this. I sometimes -- I wouldn't be upset if we're at 4%, and I wouldn't be bragging if we were at 8% or 9%. My view is, is we've got a strong support, very diversified for 5% to 7%, and I think we can consistently deliver that for the next several years. High single digits, autos; mid-single digits, Energy; and mid to upper now in financial markets with the alternatives and Ipreo piece of the puzzle.

So that makes me feel pretty confident that we don't have to do a lot of acquisitions. But I like the fact that we have $500 million to $750 million in potential acquisition capital in the framework, and we're going to analyze those bolt-on acquisitions on a regular basis. We're going to be in the know. We're going to know what's going on. If we divest, we'll create additional capital, and then we'll either move to the upper end of our capital allocation framework, buy back. We may delever short term for an opportunity we see forward, but expect discipline, expect the framework to be in place and we -- I think we're in a really good position to focus on our scaled verticals and grow those accordingly.

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Operator [50]

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Our next question comes from Toni Kaplan with Morgan Stanley.

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Toni Michele Kaplan, Morgan Stanley, Research Division - Senior Analyst [51]

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For Transportation, you mentioned that digital advertising slowed down. I'm just wondering if you view that as temporary and how you see that playing out. Should it be a drag for a couple of quarters more? Or are we largely done? And really, what's sort of going to change to fix it?

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [52]

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Yes. It's a good question, Toni. I kind of -- and Edouard's here with me today, so it's one we talk about regularly. We have a strategy in digital marketing that was very aligned to the social media platforms, Facebook, Pinterest, Google, et cetera. And our teams did a great job, and it gave us a strong growth lever for the last several years. On the back of the Cambridge Analytica and some of the changes, having the middle man-type relationship into the social media platforms is one that has had a complete readjustment. And so we've had to check back and then start to grow again.

My view, along with the Automotive team, is that the use of building audiences from comprehensive registration data -- and we have the most comprehensive data of anybody, couple that with our CARFAX assets and our Mastermind assets, we really -- we have all the ingredients to cook up the best audience for the best strategy and campaign in the marketplace. And so my personal view, which is shared by Edouard, and he may want to add to this in a moment, is that this is a growth driver long term, and we're well positioned to go after that growth. But we've now had 3, 4 quarters of that realignment of your strategy to change how you position and enter into the social media arena.

But we do -- if you take our audiences versus an audience built purely from social media without registration data but more based on taste and preferences of search, we outperformed that 50% to 100%. So we are very, very strong, and no reason we shouldn't grow. And I can't wait till I get on the call and say Automotive had a superstrong quarter on the back of digital marketing. I just haven't -- we haven't been able to say it for 3 quarters, and you're right to call it out. Edouard, do you want to add?

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Edouard Tavernier, IHS Markit Ltd. - SVP of Transportation segment [53]

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Nothing really to add other than we have the best audiences. Our customers know we have the best audiences. And we are pivoting our business model and the way we monetize those audiences, and that's taking a few quarters.

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [54]

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Thanks, Toni.

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Operator [55]

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Our next question comes from Andrew Nicholas with William Blair.

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Trevor Romeo, William Blair & Company L.L.C., Research Division - Associate [56]

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It's actually Trevor Romeo for Andrew. I think, Lance, you mentioned that you're already seen some early revenue synergies from the agribusiness group. Can you just give us a sense of the initial customer response there and more detail on what's driving those synergies?

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [57]

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Yes. So it's really the -- as you go down into the agricultural business, of course, it's the refined chemical products that are feeding into the customer base. And what we found, some of the really -- like, I'm talking within days of our teams coming together and visiting customers, was us being able to build out a couple of really interesting chemical base consulting projects from customers of the acquired company and ourselves. And so I see a lot more of that as we look forward.

Again, like us selling AD&S or selling our noncore TMT, us receiving the agribusiness from Informa, it's the same thing. It was noncore to them. So all of a sudden, they're inside a firm that has customers that look like their customers, which is exciting. Two, people that talk their lingo: chemicals, phosphates and potash and all the feedstock into agricultural products, biofuels. You've got consultants in this space. You've got researchers, and you've got people that know how to price and build benchmarks and indices. So it just is the enthusiasm of the marriage of the assets and, therefore, the customer base that we're visiting together. And so the teams had some really nice early wins, and I wanted to call them out on the call. Thank you.

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Operator [58]

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Our next question comes from Joseph Vafi with Canaccord.

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Joseph Anthony Vafi, Canaccord Genuity Corp., Research Division - Analyst [59]

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Just a follow-up on the agribusiness tier. I mean, obviously, there's good synergy on the chemical side. It's a relatively small business now for you but in a very large industry. Just does this acquisition provide the capability to perhaps overinvest in this area and move into areas, such as commodities and other things away from chemicals and more on the output side rather than the input side there?

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Lance Uggla, IHS Markit Ltd. - Chairman & CEO [60]

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Right. No, good question. And exactly what we're thinking when we did this asset swap is that if you think of agriculture as a world need and then you look at the need for the fertilizers, crop protection, the resultant biofuels, et cetera, this is a big, big TAM. And so when modeled out the TAM for the agribusiness, it was substantively larger. We've taken in a business with approximately $40 million of revenues, and so I think if you -- if we're sitting here in 3 to 5 years and we don't have more than $100 million, I'd be really -- I'd be disappointed that we didn't invest. We didn't build the revenue synergies, we didn't take the power of our global positions and apply it to agriculture. Because for a company to earn $100 million in revenue out of $4 billion, $5 billion of revenues in agriculture, it just seems really small for the TAM.

So I'm with you. Feed our capabilities from upstream, mid to downstream products into agriculture, make sure we're capturing all the inputs, benchmarks, signals, factors, supply and demand characteristics of all the inputs and outputs. I think there's a lot for us to do there, and it's a big market. So we have high hopes. It's not -- I can say that that's just in the mid-single digits forecast of our $1 billion Energy business. But it is definitely a bright spot that we think should be upper single digits to double digits in the early years of post-acquisition.

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Operator [61]

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And I'm currently showing no further questions at this time. I'd like to turn the call back over to Eric Boyer for closing remarks.

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Eric J. Boyer, IHS Markit Ltd. - VP, IR [62]

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We thank you for your interest in IHS Markit. This call can be access via replay at (855)-859-2056 or international dial-in (404) 537-3406, conference ID 4399831, beginning in about 2 hours and running through October 1, 2019.

In addition, the webcast will be archived for 1 year on our website at www.ihsmarkit.com. Thank you, and we appreciate your interest and time.

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Operator [63]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.